Openness

There are various methods to capture the openness of the country but there are no absolute answers for what is the most accurate, reasonable and reliable approach. According to Baldwin (1989), it is affirmed that both outcome and incidence-based measures can be used for measuring openness. Outcome-based measures refer to the information of policy-induced trade barriers that can be obtained from the data of the variables that presumably affect prices or trade flows. Incidence-based measures are built up from the actual data on trade barriers.

Of the outcome-based measures, the ratio of trade, normally, imports plus exports, to GDP is the simplest. However, this measure can be affected by both the economy’s structural characteristics and other external factors that lead to changes in the cost of trading. Leamer (1998) solved this problem by applying the Hecksher-Ohlin factor endowment to forecast the composition of a country’s trade without intervention. This method can be applied by using the average deviation of the actual from the predicted values resulting from the measure of openness or intervention. Only the deviation of the country from the cross-country average level can be measured with this approach.

Penetration ratios are another example of outcome-based measures. These ratios are only used to indicate restrictions on imports. Imports to GDP ratio and imports to aggregate consumption ratio are classified as penetration ratios. The latter ratio is a more reliable indicator for trade policy in developing countries because consumption goods are the most restricted goods. In terms of calculating this ratio using

23

total imports, the proportion of consumer imports to total imports is assumed to be a minimum across countries and time. The supporting reason for this criterion is that higher restrictions can be implied from a lower ratio rather than differences in composition of imports (Leamer, 1998).

The third outcome-based measure is derived from the price comparison of similar products between domestic and border prices. This measure is better than the average tariff rate since it can capture the effects of both tariff and non-tariff barriers. In addition, economic interpretation can be more easily investigated by this measure. The domestic prices and border prices of the same individual goods have to be compared through the adjusting of transport costs, distribution mark-ups and differences in quality. This practice is relatively difficult and takes time and can be done for only a few developing countries (Andriamananjara and Nash, 1997). The World Bank (1991) has measured domestic prices via international prices by using national accounts prices index data. To indicate distortions in trade regimes, differences between the domestic prices relative to international prices of tradable goods have to be taken. Underestimation of trade restrictions in trade policy, particularly in developing countries that impose tariffs on both imports and exports, is normally found. This finding leads to higher prices of importable goods than the world level whereas prices of exportable goods are lower. This index can be small despite large distortions appearing when the average deviation is measured across all tradable goods and negatives offset the positives.

The final category of outcome-based measure uses the exchange rate. An indication of the strength of trade restrictions can be drawn from the black market premium. The black market premium is a reliable proxy of the excess demand for foreign exchange. Capital flight is the key factor that causes higher volatility of the black market premium. Another outcome-based measure is the real exchange rate movement. The real exchange can be appreciated due to trade restrictions. However, estimating the equilibrium real exchange rate is difficult. Nevertheless, it is clear that trade liberalisation will depreciate the real exchange rate. Thus, real depreciation can be used to investigate trade liberalisation schemes.

The incidence-based measure consists of the average tariff rates and indexes of non-tariff barriers measures. The average statutory tariff (non-weighted, weighted,

24

import shares or production shares) or average collection rate which is the ratio of import duties collected to imports value, has to be measured to obtain the average tariffs. The legal rates do not explain anything when there are widespread exemptions or smuggling. In the same way, misleading collection rates can be misleading when exemptions are made, then the country is unable to compete with domestic production and imported inputs. This is called escalated structure (Andriamananjara and Nash, 1997). Low to moderate collection rates and high effective protection rates emerge from this escalated structure. So, presumably the best tariff-based measure is an average of statutory rates weighted by production shares. But tariff-based measures have a crucial weakness. This weakness can be seen in trade schemes of developing countries that always restrict imports with other non-tariff barriers. As a result, the tariffs are redundant for many products since the domestic producers do not get any additional protection from the tariffs. In this case, the tariff level is not a good indicator of trade policy.

To overcome this obstacle, measures of non-tariff barriers are developed (Laird and Yeats, 1988). These measures are normally combined with the number of products categories that are subjected to the barriers divided by the total product categories in the classification criteria being adopted. The most useful indicator of domestic industry protection by non-tariff barriers is the production weight index. The actual effects of non-tariff barriers vary significantly in different products and different countries.

Anderson and Neary (1994) developed a trade restrictiveness index. The effects of both tariffs and non-tariffs barriers are included in this index. Consequently, it is debatable whether this is the most theoretically accurate. However, based on the absence of domestic price, assumptions about the effects of non-tariff barriers are necessary for empirical works and the results vary depending on the assumptions are made.